6. Which of the following is a capital market instrument?
a. a six-month CD
b. a three-month Treasury bill
c. a ten-year bond
d. an agreement for a bank to loan funds directly to a company for nine months

17. If financial markets were ____, all information about any securities for sale in primary and secondary markets would be continuously and freely available to investors.
a. efficient
b. inefficient
c. perfect
d. imperfect

18. The typical role of a securities firm in a public offering of securities is to
a. purchase the entire issue for its own investment.
b. place the entire issue with a single large investor.
c. spread the issue across several investors until the entire issue is sold.
d. provide all large investors with loans so that they can invest in the offering.

19. Without the participation of financial intermediaries in financial market transactions,
a. information and transaction costs would be lower.
b. transaction costs would be higher but information costs would be unchanged.
c. information costs would be higher but transaction costs would be unchanged.
d. information and transaction costs would be higher.

20. Which of the following is most likely to be described as a depository institution?
a. finance companies
b. securities firms
c. credit unions
d. pension funds
e. insurance companies

21. In aggregate, ____ are the most dominant depository institution, with more total assets than other depository institutions.
a. commercial banks
b. savings banks
c. credit unions
d. S&Ls

23. Which of the following distinguishes credit unions from commercial banks and savings institutions?
a. Credit unions are non-profit
b. Credit unions accept deposits but do not make loans
c. Credit unions make loans but do not accept deposits
d. Savings institutions restrict their business to members who share a common bond

24. When a securities firm acts as a broker, it
a. guarantees the issuer a specific price for newly issued securities.
b. makes a market in specific securities by adjusting its own inventory.
c. executes transactions between two parties.
d. purchases securities for its own account.

25. When a securities firm acts as a(n) ____, it maintains a position in securities.
a. adviser
b. dealer
c. broker
d. none of the above

34. A five-year security was purchased two years ago by an investor who plans to resell it. The security will be sold by the investor in the so-called
a. secondary market.
b. primary market.
c. deficit market.
d. surplus market.

35. When security prices fully reflect all available information, the markets for these securities are said to be efficient.
a. True
b. False

36. If markets are perfect, securities buyers and sellers to not have full access to information and cannot always break down securities to the precise size they desire.
a. True
b. False

37. A broker executes securities transactions between two parties and charges a fee reflected in the bid-ask spread.
a. True
b. False

38. The euro increased business between European countries and created a more competitive environment in Europe.
a. True
b. False

39. In recent years, financial institutions have consolidated to capitalize on economies of scale and on economies of scope.
a. True
b. False

40. Securities are certificates that represent a claim on the provider of funds.
a. True
b. False

44. Money market securities are commonly issued in order to finance the purchase of assets such as buildings, equipment, or machinery.
a. True
b. False

45. The total asset value of savings institutions is larger than that of commercial banks.
a. True
b. False

46. Financial markets facilitating the flow of short-term funds with maturities of less than one year are known as
a. secondary markets.
b. capital markets.
c. primary markets.
d. money markets.
e. none of the above

47. Which of the following transactions would not be considered a secondary market transaction?
a. An individual investor purchases some existing shares of stock in IBM through his broker.
b. An institutional investor sells some Disney stock through its broker.
c. A firm that was privately held engages in an offering of stock to the public.
d. All of the above are secondary market transactions.

48. If investors speculate in the underlying asset rather than derivative contracts on the underlying asset, they will probably achieve ____ returns, and they are exposed to relatively ____ risk.
a. lower; lower
b. lower; higher
c. higher; lower
d. higher; higher

50. A common use of funds for ____ is investment in stocks and businesses, while their main use of funds is providing loans to households and businesses.
a. savings institutions
b. commercial banks
c. mutual funds
d. finance companies

58. The term ____ involves decisions such as how much funding to obtain, and how to invest the proceeds to expand operations.
a. corporate finance
b. investment management
c. financial markets and institutions
d. none of the above

59. There is a ____ relationship between the risk of a security and the expected return from investing in the security.
a. positive
b. negative
c. indeterminable
d. none of the above

60. If a security is undervalued, some investors would capitalize from this by purchasing that security. As a result, the security’s price will ____, resulting in a ____ return for those investors.
a. rise; lower
b. fall; higher
c. fall; lower
d. rise; higher

61. The credit crisis in the 2008-2009 period was caused by weak economies in Asia.
a. True
b. False

64. Those financial markets that facilitate the flow of short-term funds (with maturities of less than one year) are known as capital markets, while those that facilitate the flow of long-term funds are known as money markets.
a. True
b. False

65. Treasury bonds have a maturity of one to three years.
a. True
b. False

66. Since markets are efficient, institutional and individual investors should ignore the various investment instruments available.
a. True
b. False

67. Speculating with derivative contracts on an underlying asset typically results in both higher risk and higher returns than speculating in the underlying asset itself.
a. True
b. False

68. When security prices fully reflect all available information, the markets for these securities are said to be perfect.
a. True
b. False

69. Securities that are not as safe and liquid as other securities are never considered for investment by anyone.
a. True
b. False

73. Most mutual funds obtain funds by issuing securities, then lend the funds to individuals and small businesses.
a. True
b. False

74. Institutional investors not only provide financial support to companies but exercise some degree of corporate control over them.
a. True
b. False

75. Which of the following is not a reason why depository financial institutions are popular?
a. They offer deposit accounts that can accommodate the amount and liquidity characteristics desired by most surplus units.
b. They repackage funds received from deposits to provide loans of the size and maturity desired by deficit units.
c. They accept the risk on loans provided.
d. They use their information resources to act as a broker, executing securities transactions between two parties.
e. They have more expertise than individual surplus units in evaluating the creditworthiness of deficit units.

76. According to your text, which of the following is not considered a money market security?
a. Treasury bills
b. Treasury notes
c. retail CD
d. banker’s acceptance
e. commercial paper

81. When particular securities are perceived to be ____ by the market, their prices decrease when they are sold by investors.
a. undervalued
b. overvalued
c. fairly priced
d. efficient
e. none of the above

82. Which of the following are not considered depository financial institutions?
a. finance companies
b. commercial banks
c. savings institutions
d. credit unions
e. All of the above are depository financial institutions.

83. The main source of funds for ____ is proceeds from selling securities to households and businesses, while their main use of funds is providing loans to households and businesses.
a. savings institutions
b. commercial banks
c. mutual funds
d. finance companies
e. pension funds

84. Which of the following statements is incorrect?
a. Financial markets attract funds from investors and channel the funds to corporations.
b. Money markets enable corporations to borrow funds on a short-term basis so that they can support their existing operations.
c. Financial institutions serve solely as intermediaries with the financial markets and never serve as investors.
d. Investors seek to invest their funds in the stock of firms that are presently undervalued and have much potential to improve.

85. Which of the following is not a typical money market security?
a. Treasury bills
b. Treasury bonds
c. Commercial paper
d. Negotiable certificates of deposit

86. Debt securities issued by a small firm may be ________, meaning that _______ investors want to invest in those securities.
a. a. liquid; many
b. a. liquid; not many
c. a. illiquid; not many
d. a. illiquid; many

89. International integration of securities markets allows:
a. a. governments and corporations to have easier access to funding from creditors and investors in other countries.
b. a. investors and creditors to benefit from investment opportunities in other countries.
c. a. one’s country’s financial problems to adversely affect other countries.
d. a. All of the above

91. Which of the following is not an example of the government’s recent increased role in financial markets?
a. a. the Federal Reserve’s purchase of debt securities during the credit crisis
b. a. regulations changing the way that the credit risk of bonds is assessed
c. a. regulations setting maximum rates for Treasury securities
d. a. increased monitoring of stock trading and prosecution of those who trade on inside information

94. Systemic risk exists because:
a. a. there is no government regulation of financial markets.
b. a. financial institutions invest in similar securities and therefore are similarly exposed to large declines in prices of those securities.
c. a. financial institutions borrow using long-term debt securities but lend their funds for short-term periods.
d. a. financial institutions invest heavily in Treasury securities and therefore are exposed to the possibility that the government will default on its debts.

Chapter 2—Determination of Interest Rates

MULTIPLE CHOICE

1. The level of installment debt as a percentage of disposable income is generally ____ during recessionary periods.
a. higher
b. lower
c. zero
d. negative

2. At any given point in time, households would demand a ____ quantity of loanable funds at ____ rates of interest.
a. greater; higher
b. greater; lower
c. smaller; lower
d. none of the above

4. The required return to implement a given business project will be ____ if interest rates are lower. This implies that businesses will demand a ____ quantity of loanable funds when interest rates are lower.
a. greater; lower
b. lower; greater
c. lower; lower
d. greater; greater

5. If interest rates are ____, ____ projects will have positive NPVs.
a. higher; more
b. lower; more
c. lower; no
d. none of the above

6. The demand for funds resulting from business investment in short-term assets is ____ related to the number of projects implemented, and is therefore ____ related to the interest rate.
a. inversely; positively
b. positively; inversely
c. inversely; inversely
d. positively; positively

7. If economic conditions become less favorable, then:
a. expected cash flows on various projects will increase.
b. more proposed projects will have expected returns greater than the hurdle rate.
c. there would be additional acceptable business projects.
d. there would be a decreased demand by business for loanable funds.

10. Other things being equal, foreign governments and corporations would demand ____ U.S. funds if their local interest rates were lower than U.S. rates. Therefore, for a given set of foreign interest rates, foreign demand for U.S. funds is ____ related to U.S. interest rates.
a. less; inversely
b. more; positively
c. less; positively
d. more; inversely

11. For a given set of foreign interest rates, the quantity of U.S. loanable funds demanded by foreign governments or firms will be ____ U.S. interest rates.
a. positively related to
b. inversely related to
c. unrelated to
d. none of the above

12. The quantity of loanable funds supplied is normally
a. highly interest elastic.
b. more interest elastic than the demand for loanable funds.
c. less interest elastic than the demand for loanable funds.
d. equally interest elastic as the demand for loanable funds.
e. A and B

13. The ____ sector is the largest supplier of loanable funds.
a. household
b. government
c. business
d. none of the above

14. If a strong economy allows for a large ____ in households income, the supply curve will shift ____.
a. decrease; outward
b. increase; inward
c. increase; outward
d. none of the above

15. The equilibrium interest rate
a. equates the aggregate demand for funds with the aggregate supply of loanable funds.
b. equates the elasticity of the aggregate demand and supply for loanable funds.
c. decreases as the aggregate supply of loanable funds decreases.
d. increases as the aggregate demand for loanable funds decreases.

17. Which of the following is likely to cause a decrease in the equilibrium U.S. interest rate, other things being equal?
a. a decrease in savings by foreign savers
b. an increase in inflation
c. pessimistic economic projections that cause businesses to reduce expansion plans
d. a decrease in savings by U.S. households

19. If the real interest rate was negative for a period of time, then
a. inflation is expected to exceed the nominal interest rate in the future.
b. inflation is expected to be less than the nominal interest rate in the future.
c. actual inflation was less than the nominal interest rate.
d. actual inflation was greater than the nominal interest rate.

20. If inflation is expected to decrease, then
a. savers will provide less funds at the existing equilibrium interest rate.
b. the equilibrium interest rate will increase.
c. the equilibrium interest rate will decrease.
d. borrowers will demand more funds at the existing equilibrium interest rate.

21. If inflation turns out to be lower than expected
a. savers benefit.
b. borrowers benefit while savers are not affected.
c. savers and borrowers are equally affected.
d. savers are adversely affected but borrowers benefit.

22. If the economy weakens, there is ____ pressure on interest rates. If the Federal Reserve increases the money supply there is ____ pressure on interest rates (assume that inflationary expectations are not affected).
a. upward; upward
b. upward; downward
c. downward; upward
d. downward; downward

23. What is the basis of the relationship between the Fisher effect and the loanable funds theory?
a. the saver’s desire to maintain the existing real rate of interest
b. the borrower’s desire to achieve a positive real rate of interest
c. the saver’s desire to achieve a negative real rate of interest
d. B and C

24. Assume that foreign investors who have invested in U.S. securities decide to decrease their holdings of U.S. securities and to instead increase their holdings of securities in their own countries. This should cause the supply of loanable funds in the United States to ____ and should place ____ pressure on U.S. interest rates.
a. decrease; upward
b. decrease; downward
c. increase; downward
d. increase; upward

25. Assume that foreign investors who have invested in U.S. securities decide to increase their holdings of U.S. securities. This should cause the supply of loanable funds in the United States to ____ and should place ____ pressure on U.S. interest rates.
a. decrease; upward
b. decrease; downward
c. increase; downward
d. increase; upward

26. If the federal government needs to borrow additional funds, this borrowing reflects a(n) ____ in the supply of loanable funds, and a(n) ____ in the demand for loanable funds.
a. increase; no change
b. decrease; no change
c. no change; increase
d. no change; decrease

27. If the federal government reduces its budget deficit, this causes a(n) ____ in the supply of loanable funds, and a(n) ____ in the demand for loanable funds.
a. increase; no change
b. decrease; no change
c. no change; increase
d. no change; decrease

28. Due to expectations of higher inflation in the future, we would typically expect the supply of loanable funds to ____ and the demand for loanable funds to ____.
a. increase; decrease
b. increase; increase
c. decrease; increase
d. decrease; decrease

29. Due to expectations of lower inflation in the future, we would typically expect the supply of loanable funds to ____ and the demand for loanable funds to ____.
a. increase; decrease
b. increase; increase
c. decrease; increase
d. decrease; decrease

30. If the real interest rate is expected by a particular person to become negative, then the purchasing power of his or her savings would be ____, as the inflation rate is expected to be ____ the existing nominal interest rate.
a. decreasing; less than
b. decreasing; greater than
c. increasing; greater than
d. increasing; less than

33. If the real interest rate was stable over time, this would suggest that there is ____ relationship between inflation and nominal interest rate movements.
a. a positive
b. an inverse
c. no
d. an uncertain (cannot be determined from information above)

34. If inflation and nominal interest rates move more closely together over time than they did in earlier periods, this would ____ the volatility of the real interest rate movements over time.
a. increase
b. decrease
c. have an effect, which cannot be determined with above information, on
d. have no effect on

35. Canada and the U.S. are major trading partners. If Canada experiences a major increase in economic growth, it could place ____ pressure on Canadian interest rates and ____ pressure on U.S. interest rates.
a. upward; upward
b. upward; downward
c. downward; downward
d. downward; upward

37. When Japanese interest rates rise, and if exchange rate expectations remain unchanged, the most likely effect is that the supply of loanable funds provided by Japanese investors to the United States will ____, and the U.S. interest rates will ____.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

38. Which of the following will probably not result in an increase in the business demand for loanable funds?
a. an increase in positive net present value (NPV) projects
b. a reduction in interest rates on business loans
c. a recession
d. none of the above

39. If the aggregate demand for loanable funds increases without a corresponding ____ in aggregate supply, there will be a ____ of loanable funds.
a. increase; surplus
b. increase; shortage
c. decrease; surplus
d. decrease; shortage

41. Which of the following is not true regarding foreign interest rates?
a. The large flow of funds between countries causes interest rates in any given country to become more susceptible to interest rate movements in other countries.
b. The expectations of a strong dollar should cause a flow of funds to the U.S.
c. An increase in a foreign country’s interest rates will encourage investors in that country to invest their funds in other countries.
d. All of the above are true regarding foreign interest rates.

42. Which of the following is least likely to affect household demand for loanable funds?
a. a decrease in tax rates
b. an increase in interest rates
c. a reduction in positive net present value (NPV) projects available
d. All of the above are equally likely to affect household demand for loanable funds.

43. Which of the following statements is incorrect?
a. The Fed’s monetary policy is intended to control the economic conditions in the U.S.
b. The Fed’s monetary policy affects the supply of loanable funds, which affects interest rates.
c. By influencing interest rates, the Fed is able to influence the amount of money that corporations and households are willing to borrow and spend.
d. All of the statements above are true.

44. The ____ suggests that the market interest rate is determined by factors that control the supply of and demand for loanable funds.
a. Fisher effect
b. loanable funds theory
c. real interest rate
d. none of the above

45. Which of the following will probably not result in an increase in the business demand for loanable funds?
a. an increase in positive net present value (NPV) projects
b. a reduction in interest rates on business loans
c. a recession
d. All of the above will result in an increase in the business demand for loanable funds.

46. Other things being equal, a ____ quantity of U.S. funds would be demanded by foreign governments and corporations if their domestic interest rates were ____ relative to U.S. rates.
a. smaller; high
b. larger; high
c. larger; low
d. none of the above

47. The federal government demand for funds is said to be interest inelastic, or ____ to interest rates.
a. sensitive
b. insensitive
c. relatively sensitive as compared to other sectors
d. none of the above

48. If the aggregate demand for loanable funds increases without a corresponding ____ in aggregate supply, there will be a ____ of loanable funds.
a. increase; surplus
b. increase; shortage
c. decrease; surplus
d. decrease; shortage

49. The expected impact of an increased expansion by businesses is an ____ shift in the demand schedule and ____ in the supply schedule.
a. inward; an inward shift
b. inward; an outward shift
c. outward; an inward shift
d. outward; no obvious change

50. Which of the following is a valid representation of the Fisher effect?
a. i = E(INF) + iR
b. iR = E(INF) + i
c. E(INF) = i + iR
d. none of the above

55. The substantial decline in interest rates during the credit crisis is attributed to which of the following changes in the market for loanable funds?
a. a. an increase in both the supply of and the demand for loanable funds
b. a. a decrease in both the supply of and the demand for loanable funds
c. a. a decrease in the supply of loanable funds and an increase in the demand for loanable funds
d. a. an increase in the supply of loanable funds and a decrease in the demand for loanable funds

56. The crowding-out effect occurs when:
a. a. foreign investors crowd out U.S. investors in the market for loanable funds.
b. a. the federal government’s demand for loanable funds due to a higher budget deficit crowds out the private demand in the market for loanable funds.
c. a. institutional investors crowd out individual investors in the market for loanable funds.
d. a. firms and municipal governments crowd out households in the market for loanable funds.

TRUE/FALSE

57. According to the loanable funds theory, market interest rates are determined by the factors that control the supply of and demand for loanable funds.
a. True
b. False

58. The supply of loanable funds in the U.S. is partly determined by the monetary policy implemented by the Federal Reserve System.
a. True
b. False

59. At any point in time, households and businesses demand a greater quantity of loanable funds at lower rates of interest.
a. True
b. False

60. The business demand for funds resulting from short-term investments is inversely related to the number of projects implemented and inversely related to the interest rate.
a. True
b. False

61. Other things being equal, a smaller quantity of U.S. funds would be demanded by foreign governments and corporations if their domestic interest rates were high relative to U.S. rates.
a. True
b. False

63. Since the aggregate demand for loanable funds is the sum of the quantities demanded by the separate sectors, and since most of these sectors are likely to demand a larger quantity of funds at lower interest rates (other things being equal), the aggregate demand for loanable funds is positively related to interest rates at any point in time.
a. True
b. False

64. In general, suppliers of loanable funds are willing to supply more funds if the interest rate is higher.
a. True
b. False

65. If the aggregate demand for loanable funds increases without a corresponding increase in aggregate supply, there will be a surplus of loanable funds.
a. True
b. False

66. The relationship between interest rates and expected inflation is often referred to as the loanable funds theory.
a. True
b. False

67. According to the Fisher effect, if the real interest rate is zero, the nominal interest rate must be equal to the expected inflation rate.
a. True
b. False

68. To forecast interest rates using the Fisher effect, the real interest rate for an upcoming period can be forecasted by subtracting the expected inflation rate over that period from the nominal interest rate quoted for that period.
a. True
b. False

69. According to the Fisher effect, when the inflation rate is lower than anticipated, the real interest rate is relatively low.
a. True
b. False

70. Forecasters should consider future plans for corporate expansion and the future state of the economy when forecasting business demand for loanable funds.
a. True
b. False